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Investment Overview for Facebook (NASDAQ:FB)

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Below we highlight key drivers of Facebook's value that present opportunities for upside or downside to the current Trefis price estimate for Facebook.

Facebook Text & Display Ads

Facebook's Average Monthly Unique Visitors: We estimate that Facebook's average monthly unique visitors will grow from 1.39 billion at the end of 2014 to close to 2.15 billion by the end of our forecast period. The availability of Facebook across the world, including in markets where it is currently blocked, and continued success on the mobile platform will be key to achieving such growth. There could be as many as 4.2 billion Internet users worldwide by the end of our forecast period, suggesting that there may still be room for additional upside for Facebook. There could be an upside of more than 15% to our price estimate if the number of average Facebook users were to increase to around 2.5 billion by the end of Trefis forecast period, instead of the 2.15 billion we currently forecast. On the other hand, the rapidly changing competitive environment could also cause netizens to gravitate to other social networks and mobile apps in the future, leading to slower-than-expected subscriber growth for Facebook. If average number of monthly active users grow to around 1.8 billion by the end of the Trefis forecast period, there could be over 10% downside to our price estimate

Revenue per Page View: We expect Facebook's Revenue per Page View (RPM, per thousand views) to rise from around $0.62 in 2014 to about $1.30 by the end of Trefis forecast period. Facebook has taken a few initiatives off late to improve the engagement on its site. These include Timeline, Graph Search, News Feed ads, seamless integration with third-party content providers, integration of Instagram, Spotify and Netflix. However, increasing competition could also negatively impact Facebook's user engagement, especially if subscribers find other/better alternatives to connect online. If Facebook's RPM grows to $1.60, there could be 15% upside to our price estimate. On the other hand, there could be 10% downside if the figure increases to only about $1.00.

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Facebook is the world's most popular social network that helps people connect with family and friends. The company makes money primarily through display advertising, which it provides to advertisers by targeting specific demographics based on their information posted on Facebook. In addition, Facebook facilitates the purchase of virtual goods in games and applications running on Facebook's platform, charging a transaction fee on each virtual good purchased. Facebook is also making inroads into the physical goods market considering the steep growth expected in social e-commerce.

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We believe that the Text & Display Ads business is the primary source of value for Facebook for the following reason:

Text and Display Ads

This remains the biggest division for Facebook, contributing for over 85% to its overall value. This high value contribution can be attributed to two main factors: scale and user engagement. Facebook has over 1.39 billion monthly active users and the user engagement within this base is also high. These stellar metrics are a result of innovative product development at Facebook which includes Timeline, Graph Search, Messenger, Search and several other features designed with the long-term vision of ensuring that user stickiness to Facebook remains high. In future years, both scale and user engagement are expected to be strongly driven by growth in the mobile space.

Coupled with the high active user base, Facebook has also achieved success with its monetization strategy. Its move to raise the proportion of feed-based ads and make the platform less cluttered, has garnered success among marketers. Improvement in ad products, along with their targeting capabilities, has driven enhanced ROI and value for advertisers.

Payments on Virtual Goods

Facebook also makes money by acting as a platform for the purchase of virtual goods on social gaming applications, by partnering with gaming companies such as Zynga. Zynga's games like Farmville and Poker have been wildly popular, enabling Facebook to extract substantial revenues from the sale of virtual goods like Poker chips. As the virtual goods market expands further, Facebook's massive scale should continue to keep it as the preferred platform for game developers. However, the ongoing shift towards higher mobile usage from desktop usage, has caused pressure on this revenue stream.
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Mobile Advertising to Drive Future Growth

Facebook has achieved success in its efforts to improve mobile monetization. The share of mobile platform in overall advertising business has risen from 14% in Q3 2012 to 53% in Q4 2013 and around 70% presently. The rapid increase in monetization is being driven by growth in ad pricing.

While the number of ad impressions declined by 40% during 2014, due to the ongoing shift towards mobile usage and News Feed ads; the average price per ad impression rose significantly by 173% during the same period, buttressed by higher prominence of ads, better targeting, and larger number of marketers on the platform. We expect the same trend to continue in 2015 as well, albeit at narrower rates.

Social Media Advertising Is Growing Explosively

According to BIA/Kelsey, the social media advertising market in the U.S could rise from $5.1 billion in 2013 to $15 billion in 2018 at a CAGR of around 24%. We expect Facebook to heavily benefit from this growth as its News Feed ads are popular and relevant among advertisers.

Growth Could Decelerate In 2015

We believe revenue growth could slacken going forward, due to difficult year-over-year comparisons. In addition, the ongoing decrease in the total number of ad engagements could also limit revenue growth in the future. However, in the event, revenue contribution from other businesses such as Instagram, Messenger, WhatsApp,etc starts picking up, then we could again see acceleration in revenue growth in 2015.

We think investments on diverse platforms (such as Messenger, Instagram, WhatsApp, Search and Oculus) could reap multi-billion dollar businesses for the company in the long-run, and management hasn’t even begun scratching the surface of this potential. The recent $35 billion valuation of Instagram, by Citigroup is just the beginning in our view and in the next year, we could also see substantial unlocking of value in other businesses such as WhatsApp, Search and Messenger. Overall, we think all these moving parts will continue to fuel the company’s top-line growth for years to come.

Acceleration In Spending Expected During 2015

During the Q4 2014 earnings call, FB's management guided to an expense increase of 62.5% and 57.5% (at the mid-point) in GAAP and non-GAAP terms respectively during 2015. Coupled with the expected slowdown in revenue growth, this could lead to some margin erosion over the coming year.

How Does Trefis Modelling Work?

How do we get the historical numbers for this chart?

Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.

Who came up with the Trefis forecast for future years?

The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.

How does my dragging the trendline on the chart impact the stock price?

We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.

We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.

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